Obama Officials, Wall Street Talk Bad Bank Plans

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Officials from the Obama administration are holding around the clock meetings with senior Wall Street executives on how to create a new government bank to buy bad assets from major financial firms. However, people with direct knowledge of the talks tell CNBC there is no consensus on how such an entity would work or whether a plan could materialize any time soon or possibly ever.

The meetings are being held by representatives of the Treasury Department and the Federal Deposit Insurance Corp., with input from the Federal Reserve and senior Wall Street executives, these people say.

Under the plan being floated: The FDIC or some government agency would create a so-called 'bad bank'. The bank would snap up illiquid mortgage assets, such as bonds and loans, from banks and financial institutions in an effort to bolster the banking system's balance sheet and allow banks to resume modest lending to business and consumers, which has been drastically curtailed during the financial crisis.

The plan is similar to the initial bank bailout unveiled under the Bush Administration last September, and like its predecessor plan, the new initiative has recently hit a major snag.

At issue: How to value the assets that are sold to the bad bank in a way that isn't so low that the financial firms selling the toxic assets aren't declared insolvent once they shed the securities and write down losses. On the other hand, government officials feel they can't simply buy the assets at levels significantly above what the market is valuing the securities, because taxpayers would be subsidizing Wall Street's excesses.

One senior Wall Street executive says he explained the problem to government officials the other day this way: "What I told them is that our model may be valuing this stuff at 50 cents on the dollar, but the market values it at 22 cents. If we sell for 22 cents, we get creamed. But does the government want to pay us the difference?"

The answer coming from government officials is no, and that's why the plan is currently in limbo. According to people close to the discussions, the plan may morph into some hybrid of the various alternatives to the bad bank. The government may buy some of the bad assets, while other assets may be covered by insurance or some other guarantee.

The bigger problem is the complexity of the issue. People close to the talks say that there will be no quick fixes to the problem of a banking system holding more than $1 trillion of illiquid assets. For that reason, there is no draft plan in place, and the way things are going, there might not be one for at least the next 10 days or even longer, according to people with direct knowledge of the negotiations.

In fact, congressional staffers have yet to be briefed on any initiative. In addition, the situation is so complicated that some people close to the talks say that the bad bank initiative might die just like the initial Bush plan.

Rumors swirled on Wall Street and in Washington Thursday that the government had set up a meeting with Wall Street executives for the weekend to hammer out a plan. But people at the big banks say no such meeting has been set up, at least not yet. One reason is the lack of consensus on how to create the bad bank, also known as an aggregator bank.